Tech Rout Sweetens Top Trades

These four leaders of industry still boast strong fundamentals and enjoy favourable secular trends 

Vikram Barhat 17 March, 2021 | 4:28AM
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Microchip

As the concern over aggressive fiscal spending, the rapid reopening of the economy and a spike in inflation bubbled, jittery investors bailed or booked profit pushing Big Tech off a cliff, and creating some opportunities.

The selloff over the past couple of weeks broke the ongoing tech rally that pushed valuation to record highs. While the pullback pushed the Nasdaq into correction territory - defined as a drop from a recent peak of at least 10% - it created attractive openings for opportunistic investors.

A spike in bond yields further triggered a market rotation away from growth stocks, which are particularly sensitive to inflation pressures. As a result, some blue-chip stocks plunged between 10% and 20% in market value in stark contrast to their stellar 2020 performance. Although the market, and tech stocks, have since rebounded and recouped some of the losses, the high-quality names are still off their all-time peaks and remain compelling long-term growth stories.

The following tech stocks are market leaders in their domains and while not immune from short-term market volatility, they boast strong fundamentals and favourable secular trends that create a long growth runway. The recent weakness in their stock prices has little bearing on their business prospects nor their potential as solid long-term allocation bets.

 

Amazon.com Inc
Ticker AMZN
Current yield: -
Forward P/E: 61.73
Price US$3,064.75
Fair value: US$4,000
Value 23% discount
Moat Wide
Moat Trend Stable
Star rating ****
Data as of Mar 10, 2021

Ecommerce juggernaut, Amazon (AMZN) is the world's highest-grossing online retailer. The company clocked a staggering US$386 billion in net sales and approximately US$482 billion in estimated physical/digital online gross merchandise volume in 2020. Retail remained the biggest revenue generator representing nearly 83% of the total, followed by Amazon Web Services (12%), and advertising services and co-branded credit cards (6%). More than a quarter of non-AWS sales came from the international market, led by Germany, the United Kingdom, and Japan.

With colossal competitive advantages, built primarily on scale and size, the online retail giant dominates its served markets, especially e-commerce and cloud services. “AWS [Amazon’s cloud infrastructure] has driven profitability for the entire company—although it represents 10% to 15% of revenue, it generates 60% to 65% of total operating profit dollars for Amazon,” says a Morningstar equity report.

The tech major recently reported blowout fourth-quarter results, including a 44% revenue growth year over year to US$125.6 billion, handily surpassing most analyst estimates. It also reported strong EPS and upside to its revenue for the next quarter. “Amazon remains well-positioned to prosper from the shift toward e-commerce during the COVID-19 pandemic (with particular strength in groceries and staples) in the near term, but also the secular shift toward e-commerce in the long term,” says Morningstar equity analyst Dan Romanoff, who recently raised the stock’s fair value from US$3,630 to US$4,000.

 

Apple Inc
  Ticker AAPL
  Current yield: 0.68%
  Forward P/E: 28.25
  Price US$120.54
  Fair value: US$98
  Value 24% premium
  Moat Narrow
  Moat Trend Stable
  Star rating **
Data as of March 10, 2021

iPhone maker Apple (AAPL) sells a wide variety of consumer devices including smartphones, tablets, PCs, wearable and streaming devices, and subscription services. The company derives nearly 40% of revenue from the Americas while the iPhone contributes the bulk of its total revenue.

The tech major boasts highly sticky products that tend to lock consumers in its iOS ecosystem and nudges its loyal army of subscribers to its other products and services. “Apple's products run internally developed software and semiconductors, and the firm is well known for its integration of hardware, software and services,” says a Morningstar equity report, stressing that Apple’s competitive advantage is underpinned by its “ability to package hardware, software, services, and third-party applications into sleek, intuitive, and appealing devices.”

This expertise enables Apple to capture a premium on its hardware, unlike most of its peers. The company’s first-quarter results topped all expectations, led by the iPhone segment. “Apple’s iPhone revenue grew 17% year over year to a quarterly record US$65.6 billion, thanks to the new 5G iPhone 12 family,” says Morningstar sector strategist Abhinav Davuluri, who recently upped the stocks fair value from US$85 to US$98, incorporating a stronger near-term outlook due to the current 5G iPhone cycle and tailwind of work- and learning-from-home trends boosting Mac and iPad sales.

Davuluri projects strong double-digit iPhone growth in 2021 but cautions growth rates will moderate in the coming years.

 

Tesla Inc
  Ticker TSLA
  Current yield: -
  Forward P/E: 163.93
  Price US$677.58
  Fair value: US$349
  Value 93% premium
  Moat Narrow
  Moat Trend Positive
  Star rating *
Data as of March 10, 2021

Global EV leader, Tesla (TSLA) makes electric vehicles and sells energy generation and storage products for residential and commercial customers. The company delivered just under 500,000 vehicles in 2020, garnering its first full-year profit, over US$700 million.

“Tesla has a chance to be the dominant electric vehicle firm long term and is a leading autonomous vehicle player as well as a vertically integrated sustainable energy company with energy generation and storage products,” says a Morningstar equity report, but cautions competition is brewing.

Prompted by the stellar performance and improving operating margin, Morningstar sector strategist David Whiston recently raised the stock’s fair value from US$306 to US$349. The change in fair value also incorporated an increase in “total vehicles delivered over our 10-year forecast period by about 25% to 28.4 million,” by which point “Tesla’s gigafactories may become terafactories as Tesla seeks to grow its cell capacity to 3 terawatt-hours by 2030 from 0.1 terawatt-hours in 2019,” says Whiston.

However, the ongoing semiconductor shortage and its impact on the auto industry, including Tesla’s production, forced Morningstar to lower 2021 deliveries forecast for Tesla down to 800,000 from 950,000. “That is still about 60% growth from 2020 which is in line with guidance of growth this year above the firm’s planned annual growth rate of 50%,” assures Whiston, who forecasts growth rates of 50% through 2023, but expects the rate to decline after that.

 

Netflix Inc
  Ticker NFLX
  Current yield: -
  Forward P/E: 59.88
  Price US$512.10
  Fair value: US$250
  Value 103% premium
  Moat Narrow
  Moat Trend Stable
  Star rating *
Data as of March 10, 2021

Steaming heavyweight, Netflix (NFLX) offers subscription-based video content globally except in China. The largest provider in the U.S., Netflix has been expanding rapidly into overseas markets and now has more subscribers outside of the U.S.

The streamer boasts a large number of subscribers that use different devices across geographies generating a robust data set that current competitors can't rival. “The firm has used its scale to construct a massive data set that tracks every customer interaction,” says a Morningstar equity report, adding that the firm then leverages this customer data to calibrate its content purchasing decisions and produce original shows with mass appeal.

The strategy has been paying rich dividends both in terms of increased revenue and a growing global subscriber base. During the fourth quarter of 2020, Netflix clocked a 22% revenue increase (to US$6.6 billion) compared to a year ago. “Netflix ended an impressive 2020 with strong subscriber growth, beating our estimate,” says Morningstar equity analyst Neil Macker, who recently revised the stock’s fair value from US$200 to US$250.

The streaming giant scooped a staggering 8.5 million net new additions, ending the quarter with more than 203 million global paid subscribers, up 22% from a year ago. Europe, Middle East and Africa (EMEA) was the strongest segment, accounting for over half of the net subscriber additions for the quarter and over 40% of net additions for the year.

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Securities Mentioned in Article

Security NamePriceChange (%)Morningstar Rating
Amazon.com Inc3,125.98 USD-1.65Rating
Apple Inc166.23 USD-2.10Rating
Netflix Inc515.86 USD0.99Rating
Tesla Inc995.65 USD-3.38Rating

About Author

Vikram Barhat

Vikram Barhat  Vikram Barhat is a Toronto-based financial writer specializing in investing, stock markets, personal finance and other areas of the financial services industry. He also writes for CNBC, BBC, The Globe and Mail, and Toronto Star.

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